NEW YORK--(BUSINESS WIRE)--Fitch Ratings has assigned a 'BB+/RR4' rating to L Brands, Inc.'s (L Brands) $700 million issue of 20-year senior guaranteed notes. The proceeds from the issue will be used to pay down the company's $700 million in 6.9% senior guaranteed notes due July 2017. A full list of ratings follows at the end of this release.
KEY RATING DRIVERS
The ratings reflect L Brands' strong brand recognition and dominant market positions in intimate apparel and personal care and beauty products and strong operating results that is characteristic of an investment grade profile. While credit metrics have been reasonable, with leverage at or slightly below 3.5x since 2010, the 'BB+' rating takes into consideration the company's track record of shareholder-friendly activities which could push leverage above this range.
L Brands' strong business profile is anchored by its two flagship brands, Victoria's Secret (approximately 63% of sales and EBITDA including the Victoria's Secret direct business) and Bath & Body Works (approximately 30% of sales and 39% of EBITDA); a strong direct business (16% of total revenue); and a growing international footprint. The company's strong comparable store sales (comps) trends since the recession have been driven by relevant and attractive product offerings and a loyal customer base. Comps increased 5% in 2015, following a 2% increase in 2013 and 4% in 2014. In addition to positive operating leverage from strong comps growth, the company has driven margin growth through efficient inventory and expense management. EBITDA margins in the 20%+ range compare favorably to the broader retail average in the low teens.
Fiscal years 2016 and 2017 are expected to be negatively impacted by the company's recent actions at Victoria's Secret to streamline operations as well as investments related to grow China as a company-operated market (previously franchised). Notably, the company is eliminating certain merchandise categories such as swimwear and certain apparel categories representing a total of $525 million in volume (4% of total sales) beginning mid-2016. As a result, Fitch expects 2016 revenue growth to be flattish on negative low-single digit comps and 4% square footage growth, while 2017 comps could be in the 1% - 2% range due to swimwear/apparel volume loss. The combination of negative comps, margin deleverage on inventory clearance activity, and investments in the China rollout is projected to yield a 3% - 5% decline in EBITDA in 2016 to the $2.6 billion range from $2.7 billion in 2015. However, EBITDA margin is expected to remain in excess of 20% in 2016 and 2017.
Fitch expects positive comps and square footage expansion, if executed successfully, could drive overall top line growth in the 4% range beginning 2017. The growth of PINK in the U.S., which could be a $3 billion business over the next few years from approximately $2.5 billion currently, and the inclusion of the full lingerie lines in expanded Victoria's Secret stores have led to increased productivity per square foot over the past few years. International expansion provides a strong top line and profit opportunity by allowing the company to diversify outside of mall based locations and reduce operational and execution risks through its substantially franchised model (outside of the UK and Canadian markets).
--Fitch expects L Brands to produce comps (excluding its direct business) in the negative 1% - 3% range in 2016, improving to the 1% - 2% range in 2017;
--Square footage expansion, if executed successfully, could drive overall top line growth to flattish in 2016 and in the 3% to 5% range thereafter;
--Free cash flow (FCF) after regular dividends of negative $100 million to breakeven after regular dividends over the next two to three years given increased capex spend;
--Capex is expected to increase to $950 million in 2016 from $727 million in 2015 reflecting new store constructions and square footage expansion and stay in that range thereafter;
--Maintain a leverage profile in the mid-3x range with future debt funded special dividends or share buybacks potentially pushing leverage higher than the 3.3x in 2015.
A positive rating action would require both the continuation of positive operating trends and a public commitment to maintain financial leverage in the low 3x range.
A negative rating action could be driven by a trend of negative comps and/or margin compression from fashion misses, execution missteps or loss of competitive traction. A larger than expected debt-financed share repurchase or special dividend and/or leverage rising to approximately 4x would be negative for the rating.
LIQUIDITY AND DEBT STRUCTURE
Liquidity is strong, supported by a cash balance of $1.27 billion as of April 30, 2016 and the company's $1 billion revolving credit facility. The company has a comfortable maturity profile, staggered over many years. Fitch considers refinancing risk low given L Brands' strong business profile, favorable operating trends, and reasonable leverage.
Fitch expects FCF after regular dividends of negative $100 million to breakeven after regular dividends over the next two to three years given increased capex spend. Fitch assumes regular dividends will be increased by 20% to 25% annually, in line with the last few years. Capex is expected to increase to $950 million in 2016 from the $700 million range annually in 2014 - 2015, reflecting new store constructions and square footage expansion to primarily support PINK and international growth (square footage to grow by approximately 4% in 2016).
Lease-adjusted leverage stood at 3.3x as of Jan. 30, 2016. Fitch expects the company to maintain a leverage profile in the mid-3x range, and fund dividends and share repurchases with FCF and potential debt issuances. The company's shareholder-friendly posture is a key constraint to the rating.
FULL LIST OF RATING ACTIONS
Fitch currently rates L Brands as follows:
--Long-term IDR 'BB+';
--Secured bank credit facility 'BBB-/RR1';
--Senior guaranteed unsecured notes 'BB+/RR4';
--Senior unsecured notes 'BB/RR5'.
The Rating Outlook is Stable.
Date of Relevant Rating Committee: June 10, 2015.
Additional information is available on www.fitchratings.com
Corporate Rating Methodology - Including Short-Term Ratings and Parent and Subsidiary Linkage (pub. 17 Aug 2015)
Recovery Ratings and Notching Criteria for Non-Financial Corporate Issuers (pub. 05 Apr 2016)